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Uganda

Author(s):
International Monetary Fund
Published Date:
October 2011
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I. Recent Developments

1. President Museveni was inaugurated into the new term of office on May 15, and a new parliament was seated the next week. He was re-elected in February by a wide margin (68 percent). A new finance minister, Ms. Maria Kiwanuka, has been appointed. Since March, higher food and fuel prices have sparked opposition-led protests that have in some cases ended in violence.

2. GDP growth is recovering (Figure 1). Growth was robust in the first half of the fiscal year (9.0 percent y/y or 7.4 percent on a cyclically-adjusted basis), and imports and private sector credit growth have been strong, after troughs in 2009. Growth was driven by industry and services, with agricultural growth—where the preponderance of the informal economy and the poor are concentrated—moving to strongly negative.

Figure 1.Real and External Developments

3. However, inflation has accelerated sharply. Headline inflation rose from almost zero in mid-autumn to 16 percent in May. The main driver has been food prices, which rose 44 percent over the previous year, partly due to dry weather conditions and strong demand from neighboring countries. Higher food inflation has accounted for more than 60 percent of the increase in headline inflation, which has been the highest in the EAC. Uganda’s position as a net food exporter (particularly to South Sudan, western Kenya and organic markets in Europe) is important to the authorities, who have resisted domestic political pressure to limit food exports as a way of reducing prices in Uganda. The authorities are considering reducing excises taxes on kerosene and sugar, which would have a minimal impact on fiscal revenues (about 0.04% of GDP). They have resisted pressure to cut excise taxes on other petroleum products, noting that the implicit subsidy would be poorly targeted and could have a significant impact on domestic revenues. Other contributing factors to inflation include increased global fuel prices, strong domestic demand and strong money growth, the latter being reflected in increases in core inflation.

EAC Headline Inflation

4. The shilling lost value in the lead up to the elections, but pressure on the exchange rate has declined somewhat since then. The authorities explained that the depreciation stemmed mainly from pre-election hedging by corporates. The Bank of Uganda continued its regular small daily purchases of foreign exchange in order to build reserves, but since the beginning of the year has engaged in somewhat larger than usual net foreign exchange sales (intervention) of around US$130 million to help contain the pace of exchange rate depreciation prior to elections and in the face of political tensions.

5. Spending pressures, including in the context of elections, led to a reprioritization of government activities in the first three quarters of the fiscal year. During this period, non-wage recurrent spending exceeded program projections by around 1 percent of GDP. This spending, on police, security and other election-related activities, obliged the authorities to compensate by compressing spending in other sectors. Execution of the domestically-financed development budget was compressed as well, and wage growth was moderated.

6. Domestic revenues continue to perform strongly in nominal terms, limiting recourse to domestic financing. Tax collection was aided by currency depreciation: around 50 percent of tax revenues are collected on imports, which became increasingly more valuable in shilling terms. Disbursement of the World Bank’s PRSC tranche also helped avoid further recourse to borrowing from the central bank. Finally, a first payment of capital gains taxes related to the sale of an oil exploration license was set aside for future investment in infrastructure (see below).

7. The monetary policy stance has been tightened since early 2011, in response to rising inflation. The monetary policy stance was accommodative for most of 2010: by end-January, growth rates of broad and base money had increased significantly, to 40 percent and 39 percent y/y, respectively; growth in credit to the private sector reached about 37 percent (compared with 25 percent in June 2010 and 18 percent at end-2009). In recent months, the BOU has raised interest rates more forcefully, to help contain core inflation and curb second round inflationary pressures resulting from recent surges in food and fuel prices.

Figure 2.Recent Fiscal and Monetary Developments

Figure 3.Longer Term Fiscal Developments1

II. Program Performance

8. The Executive Board decided on February 11 not to complete the first review of the PSI. A supplementary spending bill equal to 1.3 percent of GDP was approved by Parliament in early January, rendering the level of authorized spending inconsistent with the agreed spending envelope in the PSI. The new spending was to be financed by net domestic financing well in excess of program targets. More generally, there was a heightened risk that additional spending pressures could arise and be accommodated, and the outlook for macroeconomic policies had become highly uncertain. The Executive Board did, however, approve modifications to the quantitative assessment criteria (QAC) for end-December 2010 (second review test date). Program targets for end-June 2011 (test date for third review) were left as indicative, with the QACs to be set at the time of the second review.

9. Four of six quarterly assessment criteria for end-December were met (Table 5). However, the floor on net international reserves (NIR) and the ceiling on net domestic assets (NDA) were missed by 0.3 and 0.8 percent of GDP, respectively. The breaches were due to the timing of the security-related exceptional spending: expenditures were frontloaded in the first half of the year by about 1¼ percent of GDP more than had been assumed in setting the quantitative assessment criteria for end-December. The total for security-related exceptional spending for the year as a whole was not affected. Net credit to government by the banking system was met, however, due to an unexpected capital gains tax payment by an oil exploration company. Base money was 0.4 percent of GDP higher than the indicative target, and minimum spending for the Poverty Action Fund (PAF) fell short of target by a minimal amount.

10. Good progress was made on structural reforms, with most benchmarks met for end-December 2010, and March-April 2011 (Table 6). By end-December, an inventory of government accounts was undertaken, with about half of the accounts (about 800) closed or frozen pending further review. The Integrated Personnel and Payroll System (IPPS) was rolled out in the pilot spending units, albeit with a one-month delay. About half of the procurement officers and accountants in spending units were rotated by December 31. The structural benchmark for March 31 to develop a set of leading economic indicators was met – the new series has been developed, but is not yet in operational use. Three structural benchmarks for April 1 were broadly met in the context of the Budget Framework Paper (BFP) for FY 2011/12: it contained details on the utility consumption of spending units and a partial timetable for introducing the national identification system. The spending in the BFP also included the exceptional security-related spending, but more importantly, full information on this transaction is now in the public domain, and the spending has been authorized by Parliament in a special supplementary budget. The benchmark to begin submitting to Cabinet regular reports on unpaid bills of spending units, based on data in the Commitment Control System (CCS) for the previous quarter of the financial year was not met, and is proposed to be reset for June 30.

III. Policy discussions

A. Overview

11. Program discussions centered on ensuring that the fiscal stance was aligned with PSI objectives and that monetary policy is being tightened to contain second-round inflation effects. The authorities reiterated their strong commitment to the PSI and its objectives. While regretting the circumstances that led to non-completion of the first review, they expressed appreciation for the Fund’s continued constructive engagement. They explained that they set stricter cash limits on spending for the remainder of FY 2010/11 to keep overall spending envelope constant—offsetting the higher spending authorizations in January to deal with unexpected election-related expenses. They reiterated their commitment to strong policies including tightening macroeconomic policies in 2011/12, repaying central bank lending associated with the exceptional security-related spending, and to work to create fiscal space for stepped up infrastructure spending over the medium-term.

B. Macroeconomic Outlook

12. Growth is expected to be about 6½ percent in 2011/12, and inflation should gradually recede with more favorable harvest conditions and tighter monetary policy. Demand for Ugandan exports in Southern Sudan is projected to remain strong, and several large infrastructure projects are getting underway. Further, some investment related to preparations for oil production is beginning to register in the national accounts. Inflation is expected to abate, particularly as a result of a strong June harvest, but not immediately, given base effects (food prices fell very sharply in the middle of CY 2010 after the start of the summer crops).

C. Fiscal Policy

13. Fiscal policy is aimed at containing the fiscal deficit for the remainder of the current fiscal year, with corrective policies commencing in FY 2011/12. For the remainder of FY 2010/11, the authorities have imposed tight cash ceilings in order to contain the fiscal deficit (including grants) to about 7½ percent of GDP and domestic financing to 5 percent of GDP. They sought to limit non-essential spending while protecting poverty alleviation priorities, wages, utilities, defense and policing, grants to local governments and other statutory items. The result, in the authorities’ view, has been a squeeze on other non-wage recurrent spending and delays in some development projects that were moving slowly. Staff welcomed this commitment to spending discipline, but expressed concern that such tight cash limits could result in accrual of domestic arrears.

14. The authorities acknowledged the risk that large shifts in spending priorities midway through the fiscal year could lead to domestic arrears. Data on expenditure arrears is prepared only once per year with a significant lag, meaning that data on arrears in FY2010/11 is not available at this time. Staff welcomed the authorities’ commitment to produce quarterly arrears reports to monitor this risk (structural benchmark for end-June). They also agreed to move to direct treasury (“straight-through”) payment for electricity and water bills of central government spending units (MEFP ¶ 14, 25).

Uganda: 2011/12 BudgetPercent of GDP
2010/112011/12
Proj.PSIBudget Speech
Revenue and Grants16.216.217.5
Domestic revenue 1/13.113.813.7
Grants3.12.53.8
Expenditure23.721.221.4
Deficit (including grants)7.554
Net external financing2.532
Net domestic financing522
Memo:
Nominal GDP (Ush billions)38,73045,68145,888
Sources: MoFPED and IMF staff calculations

Excludes one-off oil revenues.

Sources: MoFPED and IMF staff calculations

Excludes one-off oil revenues.

15. Staff stressed the importance of submission to Parliament of a FY2011/12 budget consistent with agreed PSI targets. In light of consultation lapses in the past year (the exceptional spending and the January supplementary budget), staff wished to ensure that the FY 2011/12 budget would be consistent with the PSI macroeconomic framework. The Minister’s Budget Speech on June 8 (including the associated Finance Act) is closely aligned to the PSI.2

16. The FY2011/12 budget reduces the underlying fiscal deficit significantly, while applying new resources to long-awaited priority infrastructure projects. The fiscal stance for FY2011/12 is tightened about 2.5 percentage points of GDP relative to FY 2010/11: in addition to unwinding of election-related spending and sharply reduced outlays for security-related exceptional expenditures, the draft budget envisages additional reductions in current spending. Relative to the agreement at the time of the first review, medium term fiscal consolidation is slightly slower, based on more consolidation of current spending and scaling up of investment spending (text table). The additional investment spending includes some large high priority infrastructure projects, consistent with Uganda’s National Development Plan (NDP), financed by use of the petroleum and energy funds - both already earmarked for this use.3 Even with a slightly slower pace of fiscal consolidation, Uganda’s risk of debt distress remains very low (see accompanying Bank-Fund DSA update).

Fiscal Policy Stance and Infrastructure Spending
FY2010/11FY2011/12FY2012/13FY2013/14FY2014/15
ProjProjProjProjProj
(percent of GDP)
Current spending14.810.610.310.29.9
Development spending7.810.411.710.68.8
Fiscal balance, incl grants-7.5-5.0-6.2-5.0-2.9
Fiscal balance, excl large infra. projects 1/-7.5-3.2-4.2-3.4-2.4
Nominal GDP (US$ mils)38,73045,68152,02758,45265,671

17. The authorities stressed their commitment to cease direct central bank financing of the deficit beginning with the FY 2011/12 budget. The remaining exceptional security-related spending of 0.6 percent of GDP will be financed from domestic revenues. Central bank financing will therefore reflect only the use of the government’s resources earmarked for infrastructure financing, particularly the shilling-denominated Energy Fund.

18. Medium term fiscal policy reflects a further reduction of the deficit, while scaling up infrastructure investment and repaying advances from the Bank of Uganda. Domestically-financed investment spending is projected to increase rapidly in FY 2012/13-2013/14 for already-identified infrastructure projects, particularly a hydropower project (Karuma falls dam) and the Kampala-Entebbe toll road (MEFP ¶ 21). Larger investment spending, plus slightly lower grant projections, is expected cause a temporary deterioration in fiscal balances in FY 2012/13, which will improve thereafter. Modest further consolidation of current expenditures and gradual revenue enhancement will provide the resources to gradually repay the outstanding central bank loans.

Box 1.Revenue Efficiency and Tax Exemptions in Uganda

When introduced ten years ago, Uganda’s value-added tax (VAT) reflected good international practice, with a single positive rate, a broad base, and limited exemptions. However, the introduction of numerous exemptions has undermined VAT effectiveness, and is a contributing factor to Uganda’s disappointing domestic revenue effort. Uganda’s VAT intake was 3.8 percent of GDP in FY2009/10, in comparison to 5.8, 4.6 and 4.1 percent for Kenya, Tanzania and Rwanda, respectively, despite all having a standard VAT rate of 18 percent (16 percent for Kenya). In particular, the lower intake is due to a large number of exemptions that have been adopted for intermediate goods, transforming the current VAT into something closer to an old-style manufacturer’s turnover tax in some sectors. The exemption on petroleum products, for example, will pose a serious problem in the context of future oil production.

Government revenue, excluding grants

(in percent of GDP)

Citation: 2011, 308; 10.5089/9781463922658.002.A001

Source: IMF, African Regional Economic Outlook

The corporate income tax (CIT) provides a ten-year tax holiday for export businesses and an exemption for agro-processing firms. These two exemptions are being streamlined in FY2011/12 by: (a) requiring that the Revenue Authority re-certify on an annual basis the eligibility of each taxpayer to benefit from the exemptions; and (b) narrowing the scope of the eligibility criteria, particularly for agro-processing.

After a hiatus of some years, a tax policy technical assistance mission visited Kampala in early 2011 and made a number of recommendations to enhance the revenue effort, including elimination of a number of VAT exemptions. The authorities incorporated some of these in the FY2011/12 budget, and have agreed to include further measures in the FY2012/13 budget.

19. Revenue enhancement, particularly improved VAT efficiency, will also make an important contribution to the restoration of fiscal space over the medium term. The budget for FY 2011/12 envisages a 0.6 percent of GDP increase in domestic revenues, as a result of efforts to begin streamlining numerous exemptions and investment incentives (MEFP ¶ 18) while also strengthening tax administration, following up on FAD technical assistance recommendations (text table and Box 1). To improve tax administration, the government is introducing a modern e-tax system, and establishment of the national identification system will contribute to reduced tax evasion. Significantly, Uganda will begin to catch up with Kenya and other partners by introducing guidelines to help the Uganda Revenue Authority (URA) manage transfer pricing situations. Looking forward, the authorities agree on the importance of eliminating additional tax exemptions and incentives FY 2012/13 and beyond (text table), recognizing the importance of avoiding a tax competition “race to the bottom” within the EAC Common Market. Finally, the e-tax system—once it is in place—will facilitate direct provision of VAT refunds by URA.

Uganda: Measures to Enhance Revenue Performance
Revenue measures to become effective from the start of FY 2011/12:
Eliminate VAT exemption on supply of motor vehicles or trailers of a carrying capacity of 3.5 tons or more designed for the transport of goods;
Streamline agricultural processing exemptions and 10-year export holiday under the CIT;
Eliminate government incentives for construction materials for hotels;
Eliminate investment trader regime under the VAT;
URA to issue and begin to enforce proposed transfer pricing guidelines; and
Government to begin to gazette and publish on the internet the names of beneficiaries (whether individual or corporation) of all tax expenditures.
Revenue measures to become effective in FY 2012/13:
Introduce a capital gains tax on non-business assets of individuals;
Eliminate VAT exemptions on the following intermediate products:
▸ Supply of petroleum fuels subject to excise duty, except for kerosene (motor spirit, gas oil, spirit type jet fuel, kerosene type jet fuel, as well as residual oils for use in thermal power generation to the national grid);
▸ Supply of any goods and services to the contractor and subcontractors of hydro-electric power projects;
▸ Supply of specialized vehicles, plant and machinery, feasibility studies, engineering designs, consultancy services and civil works related to hydro-electric power, roads and bridges construction, public water works, agriculture, education and health sectors; and
▸ Supply of computers, computer parts and accessories, computer software and software licenses, printers and accessories.
URA to begin to pay VAT refunds directly, rather than through budgetary appropriation.
Revenue measures to become effective in FY 2013/14:
Eliminate the following VAT exemptions:
▸ Supply of machinery used for the processing of agricultural or dairy products;
▸ Supply of packaging material exclusively used by the milling industry for packing milled products or used by the dairy industry for packing milk; and
▸ Supply of feeds for poultry and livestock.

20. The authorities intend to strengthen budget management through extensive revisions to the Public Finance and Accountability Act (PFAA). Reform of the PFAA, which is Uganda’s organic budget law, will focus on limiting the use of supplementary budgets to critical national emergencies and formalizing and tightening procedures for reallocating spending authority within a fiscal year. The new act is meant to address the issue of carrying forward unspent cash balances into a new fiscal year, strengthen internal controls to limit accumulation of arrears, and move in the direction of best international practice for securing ex ante parliamentary approval for classified expenditures (MEFP ¶ 13). The authorities are considering accelerating the budget preparation process (as has been done in Kenya) to ensure that Parliament has adequate time for approval of the budget prior to the start of the fiscal year.

21. Unexpected receipt of early oil revenues has prompted the authorities to accelerate establishment of an appropriate oil revenue management framework. Although oil will not flow at production levels for another 4-5 years, large capital gains receipts from the sale of oil exploration licenses are being paid to government. These revenues—expected to total about US$900 million—are being placed in a special subaccount at the central bank (precursor to a petroleum fund), and are earmarked to finance the large hydroelectric power project to be executed over the next four years (MEFP ¶ 21, 26). The resources belong to government and are not part of international reserves. They will be professionally managed by the central bank and be subject to quarterly public reporting. The authorities’ handling of these receipts is a precursor to a more formal oil revenue management framework that will be integrated in the revised PFAA. A key feature of the framework will be a petroleum fund to safeguard oil revenues, spending of which will be effected according to strict criteria set by Parliament and only through the budget. Keen to avoid typical “resource curse” externalities, the authorities have requested and are receiving Fund technical assistance on establishment of this framework, drawing on the experience of other Fund member countries.

D. Monetary and Exchange Rate Policies

22. Inflation has been driven predominantly by food prices, and the BoU wishes to avoid inflation contagion to the rest of the CPI basket. Nonfood prices have been far more stable.4 The authorities have tightened monetary policy since late last year, particularly by raising short-term interest rates by about 700 basis points. However, they expect that inflation will abate starting in June, as food prices are already declining with the start of the harvest season. If food prices do not abate as expected, the authorities have indicated that they will continue tightening to contain underlying inflation. Staff considers that—along with the food price shock—a much smaller component of Uganda’s higher inflation reflects lagged effects of relatively accommodative monetary policy last year. The program targets a decline in broad and reserve money growth rates in 2011/12. Staff and the authorities agree on the need for vigilance going forward, and on the fact that more determined action on the part of the BOU may be needed.

Uganda- Consumer Price Inflation

(y/y percent change)

23. Monetary policy management has continued to face challenges stemming from unpredictable shifts in short-run fiscal policy. Over the past two years, the BOU has generally been successful in implementing its reserve money program (RMP) flexibly to control inflation while stabilizing money market rates. However, liquidity management has been complicated by uneven execution of fiscal spending, leading to episodes of unintended tightening or loosening of liquidity conditions. Further, unexpected shifts in money demand have contributed to dissatisfaction with the quantity-based RMP framework, and the authorities are considering shifting their operational target away from base money to short-term interest rates. The authorities and staff agreed on the need to maintain a flexible exchange rate regime. The authorities expressed their commitment to continue to use foreign exchange intervention only to smooth out excess volatility in exchange rate movements.

24. In particular, the BoU is considering moving to a form of inflation targeting “lite” (ITL). Under their proposed framework—which would maintain the primary objective of keeping core inflation at around 5 percent over the medium term—the operating target would be a publicly-announced central bank interest rate centered on the seven-day interbank rate. As part of the proposed framework, the main tools of monetary policy would be secondary market operations (especially repos and reverse repos). Primary issues of government securities would not be used as an active tool of monetary policy, as responsibility for domestic debt management would be transferred to the ministry of finance. The central bank and the government would need to clarify financial relations between them, and formalize the current policy commitment to refrain from direct central bank financing of the deficit. Staff stressed the need for having a better understanding of the interest rate transmission mechanism, while enhancing liquidity management and forecasting. The authorities have sought technical assistance from the IMF on this issue, including with regard to central bank capital arrangements, which might need to be upgraded in tandem. Finally, the BoU is also working to upgrade its communication strategy to strengthen the link between central bank actions and inflationary expectations on the market.

E. External Sector

25. Gross reserves coverage will be gradually rebuilt over the medium term. The external sector outlook has worsened since the first review, reflecting higher energy prices and investor nervousness arising both from events in North Africa (some countries there have trade ties with Uganda) and particularly from political protests in Uganda that have occasionally turned violent in April and May. A modest drawdown in gross reserves of about US$51 million is expected in FY 2011/12, bringing the stock to around 3.2 months worth of the following year’s goods and services imports. However, in large part this decline stems from the composition of domestic financing of infrastructure projects (use of the shilling-denominated Energy Fund creates pressure on the foreign exchange market that use of the dollar-denominated Petroleum Fund does not). It also reflects the agreed schedule for repayment by government to the BoU of past advances for exceptional spending (government will undertake the last approximately $140 million out of domestic revenues in FY2011/12 out of domestic revenues, and will repay about $100 million per year to BoU for 6 years thereafter). Excluding the capital imports financed by foreign exchange resources that are not counted in reserves, reserve coverage is reduced to around 3.6 months of next year’s imports, gradually recovering to 3.9 months by FY2014/15. This relatively conservative accumulation path reflects more cautious current assumptions about the provision of donor assistance and overall capital inflows over the medium term.5 Finally, based on the experience of recent years, it is likely that some of the planned infrastructure spending will end up being delayed, with the result that the outturn for reserve cover may well prove to be more favorable than is presented here.

F. Financial Sector

26. The mission highlighted the risks stemming from the rapid increase in private sector credit and encouraged the BoU to monitor closely bank balance sheets. The BoU, reassured by the increase in bank profitability in 2010, was confident that banking sector health is improving. It indicated that there has been no indication in the data of risks from the rapid increase in credit growth. The authorities also noted that banks are now better capitalized with the introduction of new higher minimum capital requirements.6 The share of nonperforming loans in total loans (NPLs) declined to 2.1 percent in 2010, from 4.2 percent in 2009, and banking sector profitability and average return on assets improved across banks (Table 7), however, owing to rapid expansion of branch networks, some (mainly smaller) banks continue to make losses.

27. However, the authorities concurred on the need for close monitoring of bank portfolios in light of uncertainty from rising inflation and exchange rate volatility. The BoU has begun to use new stress testing techniques developed with the assistance of MCM, and found no signs of heightened risk. The authorities remain, however, vigilant and ready to act quickly to prevent any banking sector weaknesses from spreading, if and when they arise.

28. The new pension regulatory bill paves the way for future reforms in the nonbank financial sector. The long-awaited bill, previously a structural benchmark under the PSI, was passed by Parliament in April 2011. The new bill creates an independent regulatory authority for the pension sector, including for the public National Social Security Fund (NSSF). Future reforms of the pension sector are expected to allow for increased competition and free entry and exit of private pensions.

29. Progress in enhancing the supervision of nonbank financial institutions beyond the pension sector, notably the insurance sector, has been slow. Recent efforts by BoU to improve supervision of deposit-taking microfinance institutions (MDIs) have been met with resistance by the sector. An FSAP update, planned for late August, will explore these issues in detail.

G. External Borrowing

30. A debt sustainability analysis (DSA)—conducted jointly with the World Bank—continues to show that Uganda remains well below debt distress thresholds. In the baseline scenario, in the long run, the present value (PV) of public and publicly-guaranteed debt-to-GDP ratio stabilizes at about 20 percent, even with the current infrastructure investment drive, and the PV of debt-to-exports ratio plateaus at about 80 percent. This assessment is robust to the standard shocks. Debt is also sustainable on the fiscal side, with the most worrisome shock being a permanent negative blow to growth. The DSA scenarios do not encompass significant oil revenue flows, given the still large degree of uncertainty regarding their timing and size. The DSA next year is expected to present an explicit oil scenario, which should further improve the debt sustainability outlook.

31. The authorities are requesting an increase in the nonconcessional borrowing (NCB) ceiling—from US$500 million to US$800 million. This would allow room for such borrowing foreseen during the remainder of the PSI program period - in light of the authorities’ commitment to use this for infrastructure scaling up in line with the NDP, and the ample borrowing room implied by the DSA, staff supports this request: most of the current ceiling has been used up, and the authorities will need further space as they move to ramp up infrastructure spending in line with the NDP.7 The authorities consider that gradually raising the ceiling would support fiscal discipline and promote careful project appraisal and selection. Staff emphasized the importance of strengthening processes for project selection, appraisal and implementation to ensure good value for the money and to maximize the growth return on infrastructure investment.

32. A publicly-owned financial institution, Housing Finance Bank (HFB), is proposed to be excluded from the external nonconcessional borrowing (NCB) ceiling—on the grounds that it is a commercially-run concern, poses little or no fiscal risk to the government, and can borrow without government guarantee. HFB proposes to borrow about US$30 million from the African Development Bank (AfDB) and Agence Française de Développement (AFD) to support mortgage and housing development. Staff is confident that the bank satisfies the requirements set out in the Staff Guidance Note on Debt Limits in Fund-Supported Programs, and has explained to the authorities (as well as HFB) that, should this assessment change at future reviews, new borrowing by HFB would again need to be captured under the NCB ceiling.8

IV. Program issues

33. The authorities have requested waivers for the nonobservance of the quantitative assessment criteria (QACs) on NIR and NDA. As mentioned above, they explain that the deviation was due mainly to the timing of exceptional security-related spending, and does not signify a shift in the stance of policy for the year as a whole. In addition, by way of corrective actions, the monetary policy stance has been tightened since end-December, and fiscal policy will be tightened in FY2011/12 and in the medium term, including the revenue measures discussed above. On this basis, staff supports their request for a waiver, also noting the authorities’ willingness to undertake corrective actions to strengthen the fiscal position going forward in response to the concerns raised at the time of the first PSI review.

34. New QACs for end-June and end-December 2011 (test dates for the third and fourth reviews under the PSI), and supportive structural measures, are presented in the authorities’ MEFP (Attachment I to the Minister’s Letter of Intent). QACs were not established for end-June at the first review, but were left as indicative targets given the potential slippage implied by the supplementary spending authorized in January. The authorities also ask that state-owned Housing Finance Bank be excluded from the ceiling on nonconcessional borrowing under the PSI.

35. The key risk to the program is the possibility that expenditure arrears may have accrued as a result of tight cash limits imposed this fiscal year. Data on possible arrears will not be available for some months. If there are arrears, they could put pressure on execution of the FY2011/12 budget. The authorities acknowledge that their cash-based PFM system should be strengthened in key areas, such as more realistic budgeting and a stricter commitment control system. This would ensure that spending execution is more consistent with spending priorities as laid out by Parliament. They are taking steps to address these concerns, most prominently by amending the PFAA, but also by strengthening data reporting on unpaid obligations of spending units and introducing direct Treasury payments (“straight-through payments”) for electricity and water bills of government agencies.

36. Another risk to the program is that inflation may be higher or abate more slowly than currently foreseen. This could have a significant social impact, particularly considering Uganda’s lack of a formal social safety net. The World Bank is working with the authorities to devise possible options for targeted spending that could be absorbed within the existing budget, and could help alleviate the impact on the most vulnerable. Other risks include: delays in securing donor financing, and the impact on investor sentiment of any further political turmoil. Finally, execution of infrastructure projects may take longer than assumed given capacity constraints: this would result in lower fiscal deficits.

V. Staff Appraisal

37. The programmed adjustment of fiscal and monetary policies will help put Uganda on a more sustainable medium term trajectory. It will be important for the authorities to rebuild those policy buffers that contributed to macroeconomic stability over the past two years. In particular, exceptional security-related spending will end early in the fiscal year, affording some badly-needed fiscal space while ceasing pressure on reserves.

38. Staff encourages the authorities to act decisively to tighten the stance of monetary policy if inflationary outcomes continue to outpace expectations. Much of the spike in headline CPI can be attributed to food and fuel prices, but there is a domestic component. The BoU will need to remain vigilant to the risk that accommodation of the first round effects of these price shocks could spill over into underlying core inflation. This will require better coordination of short-term liquidity management and the cash management needs arising from budget execution. Looking forward, staff cautions against moving too quickly to change the monetary policy framework. ITL may be appropriate in the future, but the current juncture, with inflation well outside the authorities’ target range, is unlikely to be the most propitious time for this shift in policy.

39. Eliminating tax exemptions and incentives is the right way to address Uganda’s revenue gap. Many exemptions in the VAT are on goods that are mainly used as intermediate inputs, rather than for final consumption, thus undermining the logic of the VAT. These statutory exemptions—like the myriad investment incentives under the corporate income tax and those ad hoc tax breaks granted by government directly—vastly complicate the work of the URA, provide scope for abuse and tax evasion, and contribute to an uneven playing field within the EAC Common Market. Importantly, the effectiveness of such exemptions in achieving investment or other social objectives is never carefully assessed, highlighting the need to establish a formal “tax expenditure budget” process.

40. Stronger processes for investment project selection will be critical for maximizing the growth return from higher infrastructure spending. Infrastructure gaps are a key bottleneck to growth. Plans to improve spending efficiency through better public financial management must be combined with robust processes for project planning, appraisal and implementation to ensure good value for money. Otherwise, an important opportunity will have been missed to ameliorate Uganda’s sustained growth outlook.

41. Similarly, improving the realism of the budget is important to limit the accumulation of expenditure arrears. The planned revision of the PFAA is an opportunity to address this issue, as well as other weaknesses in the PFM system, including by devising a way to ensure that classified expenditures are subject to ex ante parliamentary approval. Establishment of an appropriate oil revenue management framework within the PFAA will be a top priority for government in FY 2011/12. Staff welcomes the authorities’ commitment to establish a credible framework to monitor arrears accumulation.

42. The authorities’ planned oil revenue management framework is encouraging. The draft plan, which is to be implemented in the context of revision to the PFAA, establishes clear roles and responsibilities for the various actors: parliament, ministry of finance, Bank of Uganda, and institutes strict requirements for transparency and accountability. Uganda’s oil wealth would be invested in infrastructure—exclusively through the budget and subject to parliamentary approval—but savings would be managed professionally subject to clear investment criteria.

43. Staff welcomes parliamentary approval of the bill creating a regulatory framework for the pension sector, as an initial step to strengthen oversight of the non-bank financial sector. Banks in Uganda are well-regulated and generally profitable. But some components of the nonbank financial sector, albeit still small, could pose risks to stability down the road. The upcoming FSAP is an important chance to identify nascent challenges to systemic stability and to discuss possible steps to head them off at an early stage.

44. Staff recommends completion of the second review under the PSI. Staff supports the authorities’ request for waivers for nonobservance of two QACs at end-December and establishment of QACs for end-June and end-December 2011. Structural reforms are advancing, and staff supports the authorities’ proposed structural benchmarks, which aim to boost revenue and strengthen public financial management.

Table 1.Uganda: Selected Economic and Financial Indicators, FY2008/09-2013/141
2008/092009/102010/112011/122012/132013/142014/15
Proj.Proj.Proj.Proj.Proj.
GDP and prices (percent change)
Real GDP7.25.26.46.67.07.07.0
GDP Deflator14.69.15.410.76.45.05.0
CPI (end of period)12.34.215.07.26.55.05.0
CPI (average)14.29.46.412.56.45.25.0
Core inflation (average)12.57.86.110.16.34.84.9
External sector (percent change)
Terms of trade (Based on commodities, deterioration -)18.824.512.4-13.9-10.7-6.50.1
Terms of trade (based on all exports, deterioration -)18.29.814.0-5.8-2.2-0.51.2
Real effective exchange rate (depreciation -)0.2-4.7
Money and credit (percent change)
Broad money (M2)26.330.325.324.218.617.017.0
Credit to the central government 29.412.9-6.88.06.34.50.5
Private sector credit31.625.335.330.821.420.620.7
Savings and investment gap (percent of GDP)-10.4-11.3-12.7-11.7-10.1-9.3-7.0
Domestic investment23.524.325.327.929.528.627.0
Public5.46.67.710.311.610.68.8
Private18.017.717.617.617.818.018.2
External sector (percent of GDP)
Current account balance (excluding grants)-10.4-11.3-12.7-11.7-10.1-9.3-7.0
Net donor inflows4.04.64.84.43.93.62.9
Public External debt (including Fund)13.815.517.719.123.528.330.6
External debt-service ratio 32.01.91.51.72.12.12.4
Government budget and debt (percent of GDP)
Revenue12.512.413.113.814.014.214.4
Grants2.62.53.12.52.01.91.7
Total expenditure and net lending-17.3-19.8-23.7-21.2-22.2-21.0-19.0
Overall balance (including grants)-2.2-4.9-7.5-5.0-6.2-5.0-2.9
Stock of domestic debt8.49.412.010.88.86.84.3
Memorandum items:
Nominal GDP (U Sh billions)30,10134,53038,73045,68152,02758,45265,671
Average exchange rate (U Sh per US$)1,9052,030
Gross foreign exchange reserves
(months of next year’s imports of goods and services)5.14.73.43.23.43.73.8
(excl. large infrastructure projects)45.14.73.53.43.63.83.9
Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

Percent of M3 at start of the period. Oil capital gains is included in FY10/11.

Percent of exports of goods and nonfactor services.

Excluding imports associated with capital spending financed by petroleum fund.

Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

Percent of M3 at start of the period. Oil capital gains is included in FY10/11.

Percent of exports of goods and nonfactor services.

Excluding imports associated with capital spending financed by petroleum fund.

Table 2.Uganda: Fiscal Operations of the Central Government, FY2008/09-2014/15 1
2008/092009/102010/112011/122012/132013/142014/15
Proj.Proj.Proj.Proj.Proj.
(USh Billions)
Total revenue and grants4,5465,1366,2757,4208,3249,40110,573
Revenue3,7584,2735,0666,2857,2808,3089,426
Tax3,5604,0674,8186,0026,9788,0049,122
International trade taxes361352441503579650735
Income taxes1,0941,3611,6352,1612,5402,9063,307
Excises9211,0251,1111,3401,5621,8172,048
Value-added tax1,1841,3291,6301,8322,0952,3942,765
Additional revenue effort000167202237267
Nontax198206248283302304304
Grants7878631,2091,1361,0441,0931,146
Budget support531467505488538534540
Project grants257396704647506559607
Expenditures and net lending5,2056,8369,1629,70511,55612,29712,455
Current expenditures3,2914,3085,7494,8385,3525,9726,530
Wages and salaries1,1841,3081,6391,7582,0292,3682,561
Interest payments357386409441607515471
Other current1,7502,6143,7002,6392,7163,0893,497
o/w exceptional security437990268
Development expenditures1,6882,3123,0334,7436,0896,2115,810
Donor-supported projects4818891,5921,8191,8752,0082,152
Government of Uganda investment1,2071,4231,4412,9244,2144,2033,658
o/w Karuma1818581,047918917
o/w Oil Refinery156827980
o/w Kampala-Entebbe highway171907309272
Net lending and investment-57-37-57-40-34-36-35
Other spending 2283253437164150150150
Overall balance
Including grants-660-1,699-2,887-2,284-3,232-2,896-1,882
Excluding grants-1,447-2,562-4,096-3,420-4,276-3,989-3,029
Including grants, excluding large infra spending3/-660-1,699-2,887-1,455-2,185-1,978-1,571
Financing6581,5072,8882,2843,2322,8961,882
External financing (net)5927589511,3552,3172,1051,697
Disbursement7469191,1251,5382,5352,3371,979
Budget support233236237122130137144
Concessional project loans5136838881,1721,3691,4491,545
Non-concessional borrowing2441,036752289
Amortization (-)-126-135-156-171-205-229-277
Exceptional financing 2/-29-26-19-13-14-4-5
Domestic financing (net)667491,937929915792185
Bank financing4758111,54582981569285
o/w Bank of Uganda2774731,79682981569285
o/w Petroleum fund withdrawals03161,047918311
o/w Energy Fund drawdowns0513
o/w Bank of Uganda Repayments00-231-226-226
o/w commercial banks198338-2520000
Nonbank financing-409-62392100100100100
Errors and omissions/financing gap-2-19300000
Memorandum Items:-
Petroleum revenue fund (US$ million)
Inflows (including interest)9092724133
Petroleum fund withdrawals-129404336108
Stock at end period909807427105-
Rev, including petroleum revenue inflows (Ush bils)3,7584,2737,1786,3527,3438,3439,435
Overall bal, incl. grants and petr. rev. inflows (Ush bils)-660-1,699-775-2,217-3,169-2,861-1,873
(Percent of GDP)
Total revenue and grants15.114.916.216.216.016.116.1
Revenue12.512.413.113.814.014.214.4
Tax11.811.812.413.113.413.713.9
International trade taxes1.21.01.11.11.11.11.1
Income taxes3.63.94.24.74.95.05.0
Excises3.13.02.92.93.03.13.1
Value-added tax3.93.84.24.04.04.14.2
Additional revenue effort0.00.00.00.40.40.40.4
Nontax0.70.60.60.60.60.50.5
Grants2.62.53.12.52.01.91.7
Budget support1.81.41.31.11.00.90.8
Project grants0.91.11.81.41.01.00.9
Expenditures and net lending17.319.823.721.222.221.019.0
Current expenditures10.912.514.810.610.310.29.9
Wages and salaries3.93.84.23.83.94.13.9
Interest payments1.21.11.11.01.20.90.7
Other current5.87.69.65.85.25.35.3
o/w exceptional security1.32.60.6
Development expenditures5.66.77.810.411.710.68.8
Donor-supported projects1.62.64.14.03.63.43.3
Government of Uganda investment4.04.13.76.48.17.25.6
o/w Karuma0.51.92.01.61.4
o/w Oil Refinery0.01.31.40.0
o/w Kampala-Entebbe highway0.41.70.50.4
Net lending and investment-0.2-0.1-0.1-0.1-0.1-0.1-0.1
Other spending 20.90.71.10.40.30.30.2
Overall balance
Including grants-2.2-4.9-7.5-5.0-6.2-5.0-2.9
Excluding grants-4.8-7.4-10.6-7.5-8.2-6.8-4.6
Including grants, excluding large Infra spending3-2.2-4.9-7.5-3.2-4.2-3.4-2.4
Financing2.24.47.55.06.25.02.9
External financing (net)2.02.22.53.04.53.62.6
Disbursement2.52.72.93.44.94.03.0
Budget support0.80.70.60.30.20.20.2
Concessional project loans1.72.02.32.62.62.52.4
Non-concessional borrowing0.00.00.00.52.01.30.4
Amortization (-)-0.4-0.4-0.4-0.4-0.4-0.4-0.4
Exceptional financing 2-0.1-0.10.00.00.00.00.0
Domestic financing (net)0.22.25.02.01.81.40.3
Bank financing1.62.34.01.81.61.20.1
o/w Bank of Uganda0.91.44.61.81.61.20.1
o/w Petroleum fund withdrawals0.00.72.01.60.5
o/w Energy Fund drawdowns0.01.1
o/w Bank of Uganda Repayments0.0-0.4-0.4-0.3
o/w commercial banks0.71.0-0.70.00.00.00.0
Nonbank financing-1.4-0.21.00.20.20.20.2
Errors and omissions/financing gap0.0-0.60.00.00.00.00.0
Memorandum Items:
Petroleum revenue fund (US$ million)
Inflows (including interest)5.50.10.10.10.0
Petroleum fund withdrawals0.00.72.01.60.5
Stock at end period5.54.32.10.50.0
Revenue, including petroleum revenue inflows12.512.418.513.914.114.314.4
Overall bal, incl. grants and petrol rev. inflows-2.2-4.9-2.0-4.9-6.1-4.9-2.9
Nominal GDP (Ush bils)30,10134,53038,73045,68152,02758,45265,671
Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

Includes arrears.

Excludes spending financed by petrol/energy funds.

Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

Includes arrears.

Excludes spending financed by petrol/energy funds.

Table 3.Uganda: Monetary Accounts, FY2008/09-2013/14 1(U Sh billions; end of period, unless otherwise indicated)
2008/092009/102011/122012/132013/142014/15
Proj.Proj.Proj.Proj.Proj.
Monetary survey
Net foreign assets5,7116,3847,9197,8308,0208,3129,206
Net domestic assets5861,9092,4165,0027,2039,50411,644
Claims on public sector (net) 2-545284-2845451,3602,0512,137
Claims on government (net)-580231-3374921,3061,9982,083
excluding oil revenue inflows2311,775
Claims on private sector3,5994,5106,1037,9839,69011,68814,111
Other items (net) 3-2,468-2,885-3,403-3,526-3,847-4,235-4,604
Money and quasi-money (M3)6,2988,29310,33512,83215,22317,81620,850
Broad money (M2)4,9216,4128,0339,97411,83213,84716,206
Foreign exchange deposits1,3771,8812,3022,8583,3913,9694,644
Bank of Uganda (BOU)
Net foreign assets5,1195,7416,9656,7186,7596,8927,605
Net domestic assets-3,169-3,307-3,846-2,856-2,212-1,578-1,393
Claims on public sector (net) 2-2,145-1,672-1,988-1,159-344348433
Claims on government (net)-2,145-1,672-1,988-1,159-344347433
Claims on commercial banks124-519999999795
Other items (net) 3-1,148-1,584-1,957-1,796-1,966-2,022-1,920
Base money1,9502,4343,1193,8624,5485,3156,212
Currency outside banks plus cash in vaults1,4691,7392,2762,8263,3243,8914,553
Commercial bank deposits with BOU4826958431,0361,2231,4241,659
Memorandum items:(12-month change, percent)
Base money20.824.828.123.817.816.916.9
M325.031.724.624.218.617.017.0
Credit to the private sector31.625.335.330.821.420.620.7
(Units indicated)
M0-to-GDP ratio (percent)6.57.08.18.58.79.19.5
M3-to-GDP ratio (percent)20.924.026.728.129.330.531.7
Base money multiplier (M2/base money)2.522.632.582.582.602.612.61
Credit to the private sector (percent of GDP)12.013.115.817.518.620.021.5
Gross reserves of BOU (US$ millions)2,4422,4981,8771,8262,0862,3022,517
Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

The public sector includes the central government, the public enterprises, and the local government.

Including valuation effects and the BOU’s claims on the private sector.

Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

The public sector includes the central government, the public enterprises, and the local government.

Including valuation effects and the BOU’s claims on the private sector.

Table 4.Uganda: Balance of Payments, FY2008/09-2013/14 1
2008/092009/102010/112011/122012/132013/142014/15
Proj.Proj.Proj.Proj.Proj.
(US$ millions)
Current account-1,238-1,490-694-1,716-1,616-1,580-1,199
Trade balance-1,846-1,698-2,018-2,209-2,239-2,387-2,266
Exports, f.o.b.2,2162,3172,4812,6112,9033,2033,580
Of which: coffee337262313336353371390
Imports, f.o.b.-4,062-4,015-4,499-4,820-5,142-5,590-5,847
Of which: oil-537-486-499-613-667-725-787
Of which: government, infrastructure related-171-386-692-836-945-813
Services (net)-440-570-640-504-354-213-29
Income (net)-287-290-221-243-261-296-276
Of which: interest on public debt-24-29-32-33-45-55-66
Transfers1,3351,0682,1861,2401,2391,3161,371
Private transfers933643757775836916974
Of which: workers’ remittances (inflows)8978518949621,0341,1081,188
Official transfers4014251,430465403400397
Of which: budget support224189167150157133134
project support135195303265195205210
capital gains tax9100000
Capital and financial account1,2501,4394501,6231,8541,7871,394
Capital account0000000
Financial account1,2501,4394501,6231,8541,7871,394
Foreign direct and portfolio investment7277317901,1501,1801,2751,386
Other investment522708-3414736745138
Medium- and long-term577563-4777021,1701,304947
Of which:
Public sector (net)322386-4936891,1531,282909
SDR allocation22400000
Build-up/drawdown of petroleum fund0-910129404336108
Disbursements3884534847591,2321,3661,005
Project support270337382580778980847
Budget support11811610250505050
Non-concessional borrowing00100250450312
Amortization due-65-67-67-70-79-84-96
Private sector (net)2551771513172238
Short-term-55145136169-72-312-489
Errors and omissions-58121-3720000
Overall balance-4770-616-38274237230
Financing47-7061638-274-237-230
Central bank net reserves (increase = -)62-5762049-261-218-216
Memorandum items:
Net donor support684770-8881594372495
Of which: budget support342305269200207183184
project support4045326858459731,1851,057
Current account balance (percent of GDP)-7.3-8.8-4.2-9.2-8.1-7.4-5.3
Trade balance (percent of GDP)-10.9-10.0-12.1-11.8-11.2-11.2-10.0
Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins on July 1.

Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins on July 1.

Table 5.Uganda: Quantitative Assessment Criteria and Indicative Targets for December 2010 1

(Cumulative change from the beginning of the fiscal year, unless otherwise stated) 2

December 31, 2010
31-Dec

Prog.
31-Dec

Adjus. Target
31-Dec

Actual
Billions of Uganda Shillings
Assessment criteria
Ceiling on the increase in net domestic assets of the Bank of Uganda 336252.9344.6Not observed
Ceiling on the increase in net claims on the central government by the banking system 3771229218Observed
(Millions of U.S. dollars unless otherwise specified)
Ceiling on the stock of external payments arrears incurred by the public sector 4000Observed
Ceiling on the contracting or guaranteeing of new nonconcessional external debt with maturities greater than one year by the public sector 45500500110Observed
Ceiling on new external debt with maturity up to one year contracted or guaranteed by the public sector 46000Observed
Minimum increase in net international reserves of the Bank of Uganda (US$mn)-4887.6-34Not observed
Indicative target(Billions of Uganda shillings)
Ceiling on the increase in base money liabilities of the Bank of Uganda 3302302450Not observed
Stock of domestic budgetary arrears under the Commitment Control System (CCS) 7
Minimum expenditures under the Poverty Action Fund (including the Universal Primary689689648.3Not observed
Education component of development expenditure)

The assessment criteria and indicative targets under the program, and their adjusters, are defined in the technical memorandum of understanding (TMU).

Fiscal year begins on July 1.

Cumulative changes are from June 2010 (averages for NDA and BM), as defined in the TMU.

Continuous assessment criterion.

To be used exclusively for infrastructure investment projects. Cumulative change from May, 2010.

Excluding normal import-related credits.

Monitored annually.

The assessment criteria and indicative targets under the program, and their adjusters, are defined in the technical memorandum of understanding (TMU).

Fiscal year begins on July 1.

Cumulative changes are from June 2010 (averages for NDA and BM), as defined in the TMU.

Continuous assessment criterion.

To be used exclusively for infrastructure investment projects. Cumulative change from May, 2010.

Excluding normal import-related credits.

Monitored annually.

Table 6.Uganda—Current Structural Benchmarks Under the PSI Status of Implementation
Policy MeasureMacroeconomic rationaleDateStatus
Fiscal Sector
Implement pilot Integrated Personnel and Payroll System (IPPS) in four (4) commissions four (4) ministries, judiciary (courts and judicature) and two (2) local governmentsStrengthen oversight and control of public payrollDecember 31, 2010Met with Delay.
Report on the implementation of mandatory rotation of accountants and procurement officersEnhance governance and accountabilityDecember 31, 2010Partly met.
Undertake an inventory of existing government accounts and close immediately those which are no longer justified by a current project or legitimate activityEnhance transparency and monitoring of public financesDecember 31, 2010Met.
Prepare and include in Budget Framework Paper (BFP) a detailed report on actual and paid consumption of electricity and water, broken down by individual spending unit at the central government level, for FY2007/08, FY2008/09, and FY2009/10To facilitate introduction of “straight-through payments” (STP) system in FY2011/12 (see measure below).April 1, 2011Met.
In the context of the BFP, announce a detailed workplan and timetable for introduction of the National Identification System—including building an interface with URA records—by 2012To enhance tax administration and facilitate the combating of money laundering and the financing of terrorism.April 1, 2011Met.
In the context of the BFP, the Minister will report full information to Parliament on the amounts of the exceptional spendingTo enhance fiscal management and transparency.April 1, 2011Met.
Begin submitting to Cabinet regular quarterly reports on unpaid bills of spending units, based on data in the Commitment Control System (CCS) for the previous quarter of the financial yearTo facilitate control and elimination of government expenditure arrears.April 1, 2011Not met.
Extend the “straight-through payment” system (STP) now employed for pensions to the utility sector (electricity, water, telephone, and rental payments)Help control accumulation of arrearsJune 30, 2011Pending.
Other
Develop a set of high frequency indicators designed to capture activity and demand in the formal sector of the economyEnhance macroeconomic informationMarch 31, 2011Met.
Table 7.Banking Sector Indicators
Dec-08Jun-09Dec-09Mar-10Jun-10Sep-10Dec-10Mar-11
Regulatory capital to risk-weighted assets20.721.120.922.721.721.220.221.2
Regulatory tier 1 capital to risk-weighted assets18.719.318.719.919.218.817.518.9
NPLs to total gross loans2.24.04.23.73.32.82.12.5
NPLs to total deposits1.62.83.02.52.11.81.41.7
Earning assets to total assets75.679.078.082.474.976.777.173.6
Large exposures to gross loans31.030.432.241.035.435.535.738.6
Large exposures to total capital106.999.294.3123.9112.8116.1124.4129.8
Return on assets4.03.12.02.33.02.43.03.3
Return on equity27.720.312.714.820.216.921.322.9
Net interest margin11.310.710.210.09.810.010.310.5
Liquid assets to total deposits48.142.244.745.541.640.539.840.5
Interbank borrowings to total deposits9.38.25.93.41.81.91.72.6
Forex exposure to regulatory tier 1 capital-1.4-2.9-0.7-3.0-3.5-11.8-1.6-2.1
Forex loans to forex deposits65.557.357.959.252.154.465.263.4
Forex assets to forex liabilities102.7109.8107.0101.198.496.398.098.1
APPENDIX. LETTER OF INTENT

June 15, 2011

Mr. John Lipsky

Acting Managing Director

International Monetary Fund

Washington, DC 20431

Dear Mr. Lipsky:

On behalf of the Government of Uganda, I would like to provide you with an update on the progress we have made under our program backed by the IMF’s Policy Support Instrument (PSI).

As you know, the Executive Board of the IMF was not able to complete the first review under the PSI. However, I am pleased to inform you that we have taken measures since that time to address the concerns of the Executive Board, and we remain fully committed to the policy objectives the PSI aims to support.

Growth has rebounded, notwithstanding some new challenges. The recovery in economic activity has been particularly strong in service and trading sectors. However, inflation has picked up, owing mainly to higher international fuel prices and to a spike in food prices within Uganda that relate to drought conditions and to robust demand for Ugandan food products from our neighbors. I wish to note that—as was the case during the 2008 round of higher food prices—Uganda has refrained from taking any steps to limit food exports to keep domestic prices low. We aim to be the breadbasket of East Africa, and are deeply committed to maintaining a liberal trade regime in the region.

We missed two of the six assessment criteria at end-December 2010 (net international reserves and net domestic assets), and request waivers for the nonobservance of these two targets. These targets were missed because some of the exceptional spending, which we had expected to take place in the second half of the fiscal year, actually had to be effected in December. While regrettable, this shift in the timing of payments had no impact on the full year cost of the exceptional spending. Looking ahead, we request the establishment of quantitative assessment criteria for end-June 2011 and end-December 2011, as set out in the attached Memorandum of Economic and Financial Policies (MEFP) and the Technical Memorandum of Understanding (TMU) that is a part of the MEFP.

The MEFP sets out the Government’s objectives and policies for the coming financial year. These are drawn from our National Development Plan (NDP), and emphasize the importance of scaling up infrastructure development to clear the most critical bottlenecks to growth and poverty reduction. The government is taking measures to tighten fiscal and monetary policies in the short run to contain inflationary pressures, and to strengthen the macroeconomic policy framework for the medium-term, to enable the scaling up of infrastructure spending while rebuilding gross international reserves in line with the PSI objectives.

The Government believes the policies set forth in the MEFP are fully sufficient to achieve the objectives of our PSI-supported program, but we as always stand ready to take any further measures that may become appropriate for this purpose. We intend to work with the IMF and other development partners in the implementation of our program, and will consult with Fund staff in advance should revisions to the policies contained in the PSI be contemplated by Government.

Sincerely yours,

/s/

Ms. Maria Kiwanuka

Minister of Finance

Ministry of Finance, Planning and Economic Development

cc: Governor Emmanuel Tumusiime-Mutebile, Bank of Uganda

Attachment I. Memorandum of Economic and Financial Policies

June 15, 2011

I. Introduction

1. Peaceful elections were successfully conducted on February 18, 2011, providing President Museveni and the ruling National Resistance Movement with a strong mandate for the coming five years. A key element of the new mandate will be to implement the National Development Plan (NDP), particularly the effort to begin closing the infrastructure gap without losing sight of our immediate poverty reduction objectives.

Purpose of the MEFP

2. This memorandum updates Uganda’s economic program under the three-year Policy Support Instrument (PSI) for the period 2010-13, approved by the IMF Executive Board on May 12, 2010. The first review of the PSI was not completed. However, the authorities have taken the necessary steps to address the issues which prevented the completion of the first review and request that the Executive Board completes the second review.

3. This memorandum outlines the performance of the economy to date during the 2010/11 fiscal year and the expected outturns for the remainder of the year. It also discusses policies and projections for the 2011/12 fiscal year and the medium term.

Performance under the PSI

4. As noted in the Letter of Intent above, four of the six quantitative assessment criteria for December 31, 2010 were met. The exceptions were the net international reserves and the net domestic assets of the central bank, which were missed only because government foreign exchange expenditures were effected in the first half of the fiscal year instead of the second half as had been envisaged when the assessment criteria were drawn up. One of the structural benchmarks for December 2010 was fully met (inventory of government accounts), one was partly met, and one was met with a slight delay. About half of accountants and procurement officers were rotated, and the integrated personnel and payroll system (IPPS) went live at the pilot sites on January 31. The structural benchmark for March 31 to develop a set of leading economic indicators was partly met, as new series were developed and have partly been aggregated into an index to inform the path of monetary policy. The three structural benchmarks for April 1 were broadly met: the Budget Framework Paper (BFP) included a report on utility consumption of spending units and a partial timetable for introduction of the national identification system. Full information on the classified exceptional expenditures is now in the public domain, and the BFP captures the associated spending.

II. Economic and Policy Developments

Outturn in 2010/11

5. Economic activity picked up in the first half of 2010/11 after a relatively (by recent historical standards) subdued outturn in 2009/10. The recovery was driven by domestic demand, notably more buoyant private sector consumption and investment demand and a more expansionary fiscal stance. Strong private sector credit growth contributed to the rebound in private sector demand. Real GDP is now expected to grow at 6.4 percent in 2010/11 compared to 5.2 percent in 2009/10. The sources of the rebound in growth include a strong recovery in private sector aggregate demand, with private sector credit expanding by about 38 percent since the start the fiscal year; continued growth of exports as demand in export markets improves in the aftermath of the recent global financial crisis; and faster growth in the industry and service sectors.

6. Inflation had been falling for most of 2010 but began to pick up in the final quarter of the year. Annual rates of headline and core inflation stood at 14 percent and 10 percent respectively in April 2011. The rise in inflation is attributable to a number of factors: the renewed buoyancy of consumer demand; high demand for Ugandan food from neighbouring countries; higher international food and fuel prices; poor domestic harvests for food crops; and higher inflation in the countries from which Uganda sources most of its imports.

7. The balance of payments has weakened in 2010/11, mainly because of a widening of the trade deficit by almost 2 percentage points of GDP. Imports are growing strongly because of higher international fuel prices, as well as the rebound in domestic demand and large one-off government imports, whereas export growth, projected at about 7 percent in dollar values, is more modest. The current account of the BOP has been boosted by the receipt of about a billion dollars in capital gains tax revenues from the oil industry, but these resources are being transparently recorded and held in a petroleum fund in the BoU. Thus, the overall BOP is projected to incur a deficit of approximately $600 million in 2010/11, reducing gross international reserves to the equivalent of 3.4 months of imports of goods and services, compared to 4.7 months in the previous fiscal year.

8. The shilling has weakened as a result of the BoP deterioration, as well as rapid broad money growth. In addition, investor caution surrounding the elections, combined with nervousness surrounding events in North Africa, caused some volatility in the market that the BoU only partly attenuated through intervention on the inter-bank foreign exchange market. Cumulatively, the nominal effective exchange rate depreciated by 11 percent in the first 10 months of 2010/11.

Monetary policy

9. The BOU began gradually tightening monetary policy in the third quarter of 2010/11 in response to the re-emergence of inflationary pressures in the economy. Growth in the monetary and credit aggregates had been relatively subdued during most of 2009/10 but began to pick up significantly in mid-2010. Banks faced strong demand for credit from the private sector, especially from firms seeking to fund capital investments. The tightening of monetary stance by the central bank led to an increase in both interbank interest rates and yields on all tenors of government securities. Growth in the money and credit aggregates began to decelerate in the third quarter of 2010/11.

The financial sector

10. The financial soundness of the banking system strengthened in the first half of 2010/11. The banking system’s annualised return on assets, which had dipped in 2009, climbed back to almost 3 percent in the second quarter of 2010/11, while non performing loans as a share of total loans fell to around 2 percent, from 4 percent in 2009. The ratio of total capital to risk-weighted assets fell slightly to 20 percent, because of very strong growth in risk-weighted assets, rather than a fall in capital. Higher minimum capital regulations came into force in March 2011. All new banks are required to have a minimum of Shs 25 billion in paid up capital, while the existing banks had to have Shs 10 billion in paid up capital by March 2011, and need to have Shs 25 billion by March 2013. All of the existing banks were able to comply with the new minimum capital requirement in March 2011. Legislation to enable banks to undertake bancassurance and offer Islamic financial products, and to introduce a capital charge for market risk, is before cabinet. Legislation to strengthen anti-money laundering is before Parliament, and Parliament has now passed the Uganda Retirement Benefits Regulatory Authority bill.

Fiscal performance during FY 2010/11

11. Revenue collections during the first ten months of FY2010/11 were slightly above target, mainly due to the effects of exchange rate depreciation. The VAT on local goods and services performed poorly, however, particularly on mobile telephone airtime, electricity, and cement. There are also structural problems in the application of VAT which Government will address as a matter of priority. Tax to GDP is projected at 12.4% by June 2011. The improvement in the tax to GDP ratio is on account of domestic income and trade taxes, due to the recovery in import volumes particularly in dutiable items, and the exchange rate depreciation.

12. The expenditure to GDP ratio is projected at almost 24% of GDP, a significant increase compared to last fiscal year. The fiscal deficit excluding foreign grants and oil revenues is projected at 10.6% of GDP compared to 7.4% in 2009/10, and is 4.5% of GDP above the target for FY2010/11. The sharp increase in Government spending was due to: increased security-related exceptional spending; wages and salaries for the lower-paid cadre of civil servants; unanticipated pension obligations; and higher thermal power costs due rising fuel prices; and unexpected elections costs.

13. The main thrust of the supplementary budgets passed during FY2010/11 was to reallocate expenditure within the spending envelope of the originally-approved budget. This has inevitably involved the reallocation of resources across and within spending ministries, but government has sought to protect PAF expenditures at approximately 95% of the indicative budgets. In addition, the exceptional classified spending was financed by a drawdown at the Bank of Uganda, and has been authorized by a supplementary budget passed by Parliament. Government plans to make good its position with the Central Bank over the medium term. Government is reviewing and intends to propose amendments to the Public Finance and Accountability Act (PFAA) to enhance the predictability of the budget by creating a contingency fund to finance emergencies and supplementary budgets, with clear criteria for its use. The revised act would also restrict virements (reallocations) between and within spending ministries and working toward best international practice in the treatment of classified expenditures.

14. Government continues to face challenges in respect of the control of expenditure arrears. In part these claims arise because of under-budgeting for fixed costs like utilities, rent, subscriptions for international organizations and term contracts under the development budget. Outside these fixed costs, a major cause of concern is court awards, whose incidence and magnitude are unpredictable. To address this problem, Government commits to provide adequate resources to cover fixed costs such as utilities, rent and pensions, and to extend the “straight-through payment” (STP) system to electricity and water, beginning with the 2011/12 Budget. In practice, this means that the Treasury will effect payment directly for spending unit obligations on water and electricity, deducting the amount paid from the releases made available to spending units.

Outlook and Medium Term Policies

Macroeconomic Objectives

15. Government’s primary macroeconomic objective is to promote rapid, broad based and sustainable economic growth, consistent with the quest to transform the country to a middle income status in the medium term. Consistent with this objective, economic growth is projected to average at least 7% per annum over the medium term. The specific medium term macroeconomic objectives in support of this transformation are to:

  • Maintain annual consumer price inflation to no more than 5 percent.

  • Promote increased private sector investment as the engine of growth, through crowding in the private sector in credit markets.

  • Rebuild foreign exchange reserves equivalent to a minimum level of 5 months of imports, to provide a cushion to the economy against any shocks from the external environment.

  • Maintain a flexible real exchange rate, which is required to ensure the competitiveness needed to support export sector growth and diversification.

  • Ensure that the medium term fiscal strategy gives priority to investments which improve productive capacity in the economy and employment creation.

  • And finally introduce a system of petroleum revenue management which is transparent, integrated in the budget process, and which emphasizes growth-enhancing infrastructure investments through the budget.

Economic Outlook

16. The economy is expected to remain buoyant in 2011/12, with real GDP growth edging up to 6.6 percent on the back of stronger domestic investment. Inflation will remain above target, mainly because of the persistence of the effects of higher fuel and food prices, but it will decline over the course of the fiscal year as monetary policy proceeds in a tightening phase. The balance of payments is expected to improve, with the overall deficit being reduced to almost zero in 2011/12 as a result of stronger capital and financial account inflows. Both foreign direct investment and donor-financed government project financing are projected to increase in 2011/12.

Monetary policy

17. The priority for monetary policy in the first half of 2011/12 will be to curb the rise in core inflation. Given the impetus from the rise in global fuel and commodity prices, as well as inflation from Uganda’s major trade partners, it is likely that headline inflation will rise to around 15 percent by the end of 2010/11 before falling back during the course of 2011/12. In 2011/12, both broad and base money growth will slow to about 24 percent, and the BoU stands ready to tighten policies further if needed to rein in core inflation. The BoU intends to keep core inflation contained to below 5 percent over the medium term, and increasingly rely on the short term interest rate as an operational target for monetary policy in the process of preparing to move toward a form of inflation targeting (see below).

Fiscal strategy for 2011/12 and the medium term

18. The budget for FY 2011/12 will be consistent with the understandings reached in the context of the PSI. Government recognizes the importance of revenue enhancement for ensuring fiscal sustainability. Petroleum revenue, when it comes, will not be a panacea, so there is a need to begin catching up with neighboring countries in terms of revenue performance. The measures we intend to adopt will eliminate many exemptions or incentives in the tax system which have outlived their usefulness. In FY2011/12 government intends to take a number of important measures to help secure the revenue yield of that year and lay the groundwork for more robust revenue performance over the medium term. These measures, which will be outlined in the Minister’s Budget Speech and—where appropriate—in the Finance Act 2011/12, include:

  • Eliminate VAT exemption on supply of motor vehicles or trailers of a carrying capacity of 3.5 tons or more designed for the transport of goods (Finance Act);

  • Streamline agricultural processing exemption and 10-year export holiday under the corporate income tax, particularly by requiring that URA recertify on an annual basis the eligibility of each taxpayer for the exemption (Finance Act);

  • Terminate government incentives for construction materials for hotels;

  • Scrap investment trader regime under the VAT (Finance Act);

  • URA to issue (by June 30, 2011) and begin to enforce (from July 2011) proposed transfer pricing guidelines; and

  • Government to begin to gazette and publish on the internet the names of beneficiaries (whether individual or corporation) of all tax expenditures.

19. Some tax policy reforms will take time to prepare, and in a few cases additional technical assistance may be required. We therefore intend, in the context of the 2012/13 budget, to eliminate a number of additional exemptions, particularly of intermediate sales under the VAT. Beginning in 2012/13, URA will also begin to pay VAT refunds directly, rather than through budgetary appropriation, in order to speed refunds and improve the efficiency of this tax.

20. Government expenditure policy in 2011/12 will emphasize a prudent expansion in public investment in line with the NDP. Beyond these flagship investment projects, expenditures will be restrained in view of our limited resources, including in light of declining donor assistance. Large scale classified expenditures will abate. Nevertheless, we recognize that the major risk to the fiscal outlook for 2011/12 is the possibility of expenditure arrears. If, in the event, expenditure arrears are found to have accumulated in FY2010/11, government will seed to clear them in FY 2011/12 through reallocations from lower priority spending.

21. In the medium term, the fiscal strategy will focus on implementing a few identified priority infrastructure projects in the NDP to unlock the most critical binding constraints to economic growth. In addition to the on-going infrastructure projects already in the MTEF, the new projects which will commence in FY2011/12 include Karuma hydropower project, the oil refinery, and the Kampala-Entebbe express highway. These projects are to be financed mainly by savings accumulated in previous years (Energy Fund), oil revenues, some nonconcessional borrowing for the highway, and government’s own current domestic revenues. Other projects to be implemented in the medium term include the rehabilitation of Tororo-Pakwach railway, construction of Kampala-Jinja dual carriage way, and Kampala metropolitan roads to decongest the traffic in and around Kampala. In light of the large backlog of critical infrastructure projects, we seek an increase in the ceiling on nonconcessional borrowing (NCB) under the program (see below). The Government will work closely with Fund staff to ensure that financing mechanisms, particularly nonconcessional, do not pose any threat to macroeconomic or debt sustainability.

III. Structural Issues and Reforms

Revenue administration modernization

22. Government plans to continue with revenue administration reforms in addition to the tax policy changes noted above. To improve tax administration and reduce cost of compliance, the use of e-tax services is being rolled out across the country to facilitate taxpayers’ registration, filing and payments. In addition, Government will introduce Electronic Tax Registers (ETRs) and e-tax receipting and auditing system to reduce taxpayer compliance costs. The implementation of the E-tax will continue in a phased manner, starting with large and medium taxpayers. Government will support VAT taxpayers to install Electronic Cash Registers at their premises to record and relay sales information to the URA automatically. Introduction of e-tax will allow URA to pay VAT refunds directly, rather than through budgetary appropriation, beginning in 2012/13. Introduction of the national identification system will proceed in stages, with an initial 4 million citizens covered by June 30, 2012.

Public Finance Management

23. During FY 2011/12, the Government will propose to Parliament revisions to the Public Finance and Accountability Act (PFAA) of 2003 with the aim of strengthening public finance management. Key objectives in this regard include measures to limit strictly the use of supplementary budgets to serious national emergencies, and to restrict virement (reallocation) abilities both across and within spending ministries. In the new PFAA, Government will ensure that any significant reallocation of spending authorities will require ex-ante approval from parliament. In the context of introducing amendments to the PFAA, Government intends to move to a treasury single account system for administering government finances, recognizing this practice will improve cash management and reduce the cost of government borrowing. Further, to ensure realism and credibility of the budget, and strict adherence to annual work plans of spending units, the authorities plan to consider in the PFAA amendments advancing the budget timetable to enable Parliamentary budgetary approval before the start of each new fiscal year.

24. It is hoped that the revised PFAA will also clarify and limit the ability of government to carry forward expenditure appropriation from one fiscal year to the next. In the meantime, to limit the potential for abuse and diversion of funds, government will take the following measures regarding unspent balances at the end of FY 2011/12: (i) publishing the balances on all government accounts both in the BoU and in commercial banks as at June 30 and September 30, (ii) Minister responsible for finance to present these accounts to parliament by July 31 and October 30, respectively; (iii) parliamentary approval, as well as supporting work and procurement plans, will be required in order to spend any balances held over from the previous year; and (iv) all unspent balances which have not been re-appropriated by parliament by end-September must be returned immediately to the government Consolidated Fund.

25. Government acknowledges that internal controls to prevent the accumulation of expenditure arrears need to be strengthened. In the context of amendments to the PFAA, Government will take steps to strengthen the Commitment Control system (CCS), including by introducing strong sanctions on accounting officers who are found to have incurred expenditure obligations outside the CCS. The ministry of finance will also begin to report to cabinet on a quarterly basis information on the unpaid claims on spending units. In the meantime, to minimize accumulation of arrears, beginning with FY2011/12 government will extend the “straight-through payment” (STP) system now employed for pensions to utility payments (electricity and water payments) of spending units.

Oil Revenue Management

26. Government aims to provide for the prudent management and accountability of petroleum resources in the context of amendments to the PFAA. Our objective is to ensure that the necessary mechanisms for transparency and accountability are in place before large scale oil revenues begin to accrue. We intend to establish a Petroleum Fund into which all oil and gas revenues will be deposited, and we will ensure that all spending is done through the budget. The BoU is to act as the investment manager for these resources on behalf of government, and they will pursue an investment strategy that is—at least in the short run—consistent with their handling of Uganda’s foreign exchange reserves. Until the revised PFAA is passed, we are handling the payments of significant capital gains tax revenues consistent with these objectives. We have placed these funds on a special account in the BoU, on which we will report publicly on at least a quarterly basis. Flows out of this account will only be made to the budget and for the near term will be used for financing the Karuma hydropower project.

27. Looking to the medium term, the manner in which oil revenue will be managed must not compromise the growth and export potential of non-oil sectors in order to enhance employment creation in the country. This will entail building capacity in managing oil resources and also research capacity.

Debt sustainability in the context of improved asset and liability management

28. Government plans to update our debt strategy to ensure continued debt sustainability in the context of accelerated public infrastructure investment. We envisage an increase in the nonconcessional borrowing ceiling under the program (from $500 million to $800 million), still earmarked for infrastructure, with the state-owned Housing Finance Bank excluded from the ceiling. With technical support from the IMF and other partners, we intend to review options for external and domestic financing, including the use of public-private partnership (PPP) arrangements. At this time we have no concrete plans to move to international capital markets or to place large-scale domestic debt issuance dedicated to infrastructure.

29. Government recognizes that the most pressing constraint to stepped up infrastructure investment is our own system of project assessment, planning, and implementation. We intend to put in place an evaluation and appraisal criteria to ensure that all projects funded are economically and financially viable and consistent with the overall macroeconomic framework to ensure continued stability.

30. As we establish the legal framework for administering petroleum wealth through the amended PFAA, we will need to review our preparedness for asset management. The petroleum fund will be administered by the BoU, but the investment guidelines and risk tolerance will be set by the government. In this regard, we also look forward to technical support from the IMF, insofar as asset and liability management must be viewed as a package.

Enhancing the framework for monetary policy

31. The authorities are considering reforms to the BoU’s operating framework for monetary policy, which would entail replacing the current monetary targeting framework with an inflation targeting lite (ITL) framework, the primary policy objective of which will continue to be maintaining core inflation (which excludes the prices of fuel and food crops) at an annual level of 5 percent on average over the medium term.

32. In this regard, it will be important to clarify the financial relations between the Bank of Uganda and the government, including reviewing central bank capital arrangements and limiting direct central bank financing of the government borrowing requirement. Our intention is also to strictly delineate and ringfence the stock of government securities useable for liquidity management purposes as distinct from that intended for fiscal financing purposes. The BoU will begin regular inclusion in its Quarterly Report of data on the net and gross positions of government in the BoU.

33. The central bank will upgrade its communication strategy to provide the public with clarity about the stance and objectives of monetary policy. The authorities have requested the Fund to provide technical assistance and advice on the introduction of inflation targeting, in particular to draw lessons from the experience of other African and developing country central banks, including in the context of IMF program monitoring.

34. Further, the BoU is working with the Uganda Bureau of Statistics to develop high frequency indicators of activity and demand in the formal sector of the economy. The following data have so far been collected and compiled: index of agricultural production (2-month lag); quarterly GDP; index of manufacturing production based on the 50 large companies; index of construction; and sales data on selected consumer products, building materials, and petroleum (all with a 3-month lag). Efforts are being made to extend the coverage of the index of agricultural production, and collect data on urban employment and the transport & communication sector. We intend to produce and begin disseminating a synthetic index of economic activity to help guide the conduct of monetary policy by September 30, 2011.

IV. Program Monitoring

35. Progress in the implementation of the policies under this program will be monitored through assessment criteria (ACs), indicative targets (IT), and structural benchmarks (SBs), detailed in the attached Tables 1 and 2 and through semiannual reviews. Assessment criteria are added for end-June 2011 and proposed for end-December 2011, to be monitored respectively at the third and fourth reviews. The third review is expected to be completed by end-December 2011, and the fourth review by end-June 2012. The attached Technical Memorandum of Understanding—which is an integral part of this Memorandum—contains definitions and adjustors. During the program period, we will refrain from imposing or intensifying exchange restrictions as well as restrictions on imports for balance of payments reasons, or from introducing multiple currency practices.

Table 1.Uganda: Quantitative Assessment Criteria and Indicative Targets for December 2010 - June 2012 1

(Cumulative change from the beginning of the fiscal year, unless otherwise stated)2

December 31
201020112011 3/20112012 3/2012 3/
31-Dec Prog.31-Dec Adjus.Target31-Dec ActualJune 30Sep. 30Dec. 31March 31June 30
Billions of Uganda Shillings
Assessment criteria
Ceiling on the increase in net domestic assets of the Bank of Uganda 4/36252.9344.6Not observed2,0934098771,1671,150
Ceiling on the increase in net claims on the central government by the banking system 4/771229218Observed1,545274633987829
(Millions of U.S. dollars unless otherwise specified)
Ceiling on the stock of external payments arrears incurred by the public sector 5/000Observed00000
Ceiling on the contracting or guaranteeing of new nonconcessional external debt with maturities greater than one year by the public sector 5/ 6/500500110Observed500800800800800
Ceiling on new external debt with maturity up to one year contracted or guaranteed by the public sector 5/ 7/000Observed00000
Minimum increase in net international reserves of the Bank of Uganda (US$mn)-4887.6-34Not observed-622-66-121-147-51
Share of oil revenue placed into Petroleum Fund100100100100100
Indicative target(Billions of Uganda shillings)
Ceiling on the increase in base money liabilities of the Bank of Uganda 4/302302450Not observed685187399557743
Stock of domestic budgetary arrears under the Commitment Control System (CCS) 8/17650
Minimum expenditures under the Poverty Action Fund (including the Universal Primary689689648.3Not observed12856501400
Education component of development expenditure)
Memorandum item
Oil revenue inflows to the petroleum fund (in millions of U.S. dollars)90927

The assessment criteria and indicative targets under the program, and their adjusters, are defined in the technical memorandum of understanding (TMU).

Fiscal year begins on July 1.

Indicative targets.

Cumulative changes are from June 2010 (averages for NDA and BM) for December 2010 and June 2011 targets and from June 2011 for FY 2011/12 targets, as defined in the TMU; all targets excluding oil revenue inflows to the petroleum fund

Continuous assessment criterion.

To be used exclusively for infrastructure investment projects. Cumulative change from May, 2010.

Excluding normal import-related credits.

Monitored annually.

The assessment criteria and indicative targets under the program, and their adjusters, are defined in the technical memorandum of understanding (TMU).

Fiscal year begins on July 1.

Indicative targets.

Cumulative changes are from June 2010 (averages for NDA and BM) for December 2010 and June 2011 targets and from June 2011 for FY 2011/12 targets, as defined in the TMU; all targets excluding oil revenue inflows to the petroleum fund

Continuous assessment criterion.

To be used exclusively for infrastructure investment projects. Cumulative change from May, 2010.

Excluding normal import-related credits.

Monitored annually.

Table 2.Structural Benchmarks
Policy MeasureMacroeconomic RationaleDeadline
Government to begin to gazette and publish on the internet the names of beneficiaries (whether individual or corporation) of all tax expenditures.Enforce discipline in issuance of tax exemptions.September 30, 2011, and quarterly thereafter
URA to issue and begin to enforce proposed transfer pricing guidelines. (¶18)To reduce tax planning and prepare for large scale petroleum revenues.Issued by June 30, 2011, for enforcement beginning in July 2011.
Government to maintain transparency over the treatment of unspent budgetary funds at the end of the fiscal year by (i) publishing the balances as at June 30 and September 30 on all government accounts in the BoU and commercial banks, and (ii) in order to spend any balances held over from the previous year beyond end-June, parliamentary approval as well as supporting work and procurement plans will be required. (¶24)To enhance budgetary discipline and promote fiscal transparency.July 31, 2011, and October 30, 2011, respectively.
Begin submitting to Cabinet regular quarterly reports on unpaid bills of spending units based on data in the Commitment Control System (CCS) for the previous quarter of the fiscal year. (¶25)To facilitate control and elimination of expenditure arrearsJune 30, 2011, for the report covering Q3 of FY2010/11, and quarterly thereafter.
Extend the “straight-through payment” system (STP) now employed for pensions to the utility sector (electricity, water) (¶25)Help control accumulation of arrearsJuly 1, 2011.
As part of introduction of national identification system, 4 million additional citizens will have received IDs. (¶22)To support efforts to strengthen revenue collection and combat money laundering and the financing of terrorism.June 30, 2012.
Produce and disseminate within government a monthly index of economic activity relying on the various high-frequency indicators available. (¶32)To facilitate the conduct of monetary policy.September 30, 2011, and quarterly thereafter.
BoU to include in Quarterly Report data on the net and gross positions of government in the BoU. (¶31)Enhance central bank independence and prepare Bank of Uganda to move toward inflation targeting.September 30, 2011, and monthly thereafter.

Attachment II. Uganda: Technical Memorandum of Understanding

I. Introduction

1. This memorandum defines the quarterly assessment criteria and indicative targets described in the memorandum of economic and financial policies (MEFP) for the period of July 1, 2011-May 2013 financial program supported by the IMF Policy Support Instrument (PSI), and sets forth the reporting requirements under the instrument.

II. Ceiling on the Cumulative Increase in Net Domestic Assets (NDA) of the Bank of Uganda (BOU)

2. The net foreign assets of the BOU are defined as the monthly average (based on daily data) of foreign assets minus foreign liabilities, and include all foreign claims and liabilities of the central bank excluding oil revenues in the petroleum fund. The monthly average values of all foreign assets and liabilities will be converted into U.S. dollars at each test date using the average cross exchange rates referred to in the table below for the various currencies and then converted into Uganda shillings using the program average U.S. dollar-Uganda shilling exchange rate for October 2010.

Program Exchange Rates (US$ per currency unit, unless indicated otherwise)
USD1.0000
British Pound1.5851
Euro1.3888
Kenya Shilling0.0124
Tanzania Shilling0.0007
Japanese Yen0.0122
SDR1.5691
Uganda Shilling2,264.8

3. Net domestic assets (NDA) of the Bank of Uganda (BOU) are defined as the monthly average (based on daily data) of base money (defined below) less net foreign assets of the BOU (as defined in para. 2). Based on this definition, the NDA limits will be ceilings on the cumulative change from the monthly average based on daily data for June 2010 to the same monthly average for June 2011, and cumulative changes from the monthly average based on daily data for June 2011 to the same monthly averages for September 2011, December 2011, March and June 2012.

In billions of Uganda Shillings
June 30, 2011 1/September 30, 2011 2/December 31, 2011 2/March 2012 2/June 30, 2012 2/
Cumulative change in base money685187399557743
Cumulative change in NFA-1408-222-478-610-408
Cumulative change in NDA209340987711671150

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

III. Base Money

4. Base money is defined as the sum of currency issued by Bank of Uganda (BOU) and the commercial banks’ deposits in the BOU. The commercial bank deposits include the statutory required reserves and excess reserves held at the BOU and are net of the deposits of closed banks at the BOU and Development Finance Funds (DFF) contributed by commercial banks held at the BOU. The base money limits will be cumulative change from the monthly average based on daily data for June 2010 to the same monthly average for June 2011, and cumulative changes from the monthly average for June 2011 to the same monthly average for September and December 2011, and March and June 2012.

IV. Ceiling on the Cumulative Increase in Net Claims on the Central Government by the Banking System1

5. Net claims on the central government (NCG) by the banking system is defined as the difference between the outstanding amount of bank credits to the central government and the central government’s deposits with the banking system, excluding oil revenues in the petroleum fund and deposits in administered accounts and project accounts with the banking system, including the central bank. Credits comprise bank loans and advances to the government and holdings of government securities and promissory notes. Central government’s deposits with the banking system include the full amount of resources freed by the IMF MDRI. NCG will be calculated based on data from balance sheets of the monetary authority and commercial banks as per the monetary survey. The quarterly limits on the change in NCG by the banking system will be cumulative beginning end-June in the previous fiscal year.

V. Floor on Net International Reserves of the Bank of Uganda

6. Net international reserves (NIR) of the BOU are defined for program monitoring purpose as reserve assets of the BOU net of short-term external liabilities of the BOU. Reserve assets are defined as external assets readily available to, and controlled by, the BOU and exclude pledged or otherwise encumbered external assets, including, but not limited to, assets used as collateral or guarantees for third-party liabilities. Short-term external liabilities are defined as liabilities to nonresidents, of original maturities less than one year, contracted by the BOU and include outstanding IMF purchases and loans.

7. For program-monitoring purposes, reserve assets and short-term liabilities at the end of each test period will be calculated in U.S. dollars by converting the stock from their original currency denomination at program exchange rates (as specified in para 2).

VI. Ceiling on the Stock of Domestic Budgetary Arrears of the Central Government

8. The stock of domestic payment arrears under the Commitment Controls System (CCS) will be monitored on an annual basis. Domestic payments arrears under the CCS are defined as the sum of all bills that have been received by a central government spending unit or line ministry delivered prior to the beginning of the current fiscal year, and for which payment has not been made by end of fiscal year, under the recurrent expenditure budget (excluding court awards, subscription to international organization and pensions) or the development expenditure budget. For the purpose of program monitoring, the CCS reports, which will include arrears accumulated at IFMS and non-IFMS sites, prepared by the Accountant General, will be used to monitor arrears. Arrears can be cleared in cash or through debt swaps. According to the report prepared by Office of the Auditor General, the stock of arrears was estimated at USh 176.5 billion as of June 2010.2

VII. Expenditures under the Poverty Action Fund (PAF).

9. The compliance with the indicative target on minimum expenditures under the PAF will be verified on the basis of releases (PAF resources made available to spending agencies).

VIII. Adjusters

10. The NDA and NIR targets are based on program assumptions regarding budget support, assistance provided under the Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI), and external debt-service payments.

11. The NCG target, in addition to being based on the aforementioned assumptions, is also based on assumptions regarding domestic nonbank financing of central government fiscal operations. In addition, the NDA target depends on the legal reserve requirements on deposits in commercial banks. Finally, the NDA and NIR targets are based on program assumptions regarding automatic access by commercial banks to the BOU’s rediscount and discount window facilities.

12. The Uganda shilling equivalent of projected budget support (grants and loans) plus HIPC Initiative assistance in the form of grants on a cumulative basis from July 1 of the fiscal year is presented under Schedule A. The ceilings on the cumulative increase in NDA and NCG will be adjusted downward (upward), and the floor on the cumulative increase in NIR of the BOU will be adjusted upward (downward) by the amount by which budget support, grants and loans, plus HIPC Initiative and MDRI assistance, exceeds (falls short of) the projected amounts.

Schedule A: Budget Support Plus Total HIPC Initiative Assistance

(Cumulative billions of Uganda’s shillings, beginning July 1 of the fiscal year)

Quarter6/30/2011 1/9/30/2011 2/12/31/2011 2/3/31/2012 2/6/30/2012 2/
Budget support, including742.0255.7426.4499.9620.3
HIPC Initiative grants
Source:

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

Source:

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

13. The ceiling on the increases in NDA and NCG will be adjusted downward (upward) and the floor on the increase in NIR will be adjusted upward (downward) by the amount by which debt service due 3 plus payments of external debt arrears less deferred payments (exceptional financing) falls short of (exceeds) the projections presented in Schedule B. Deferred payments are defined to be (i) all debt service rescheduled under the HIPC Initiative; and (ii) payments falling due to all non-HIPC Initiative creditors that are not currently being serviced by the authorities (that is, gross new arrears being incurred).

Schedule B: Debt Service

(Cumulative billions of Uganda’s shillings, beginning July 1 of the fiscal year)

Quarter6/30/2011 1/9/30/2011 2/12/31/2011 2/3/31/2012 2/6/30/2012 2/
Debt Service due before HIPC excluding exceptional financing243.049.9144.8210.9263.2
Source:

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

Source:

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

14. The ceiling on the increase in NCG will be adjusted downward (upward) by any excess (shortfall) in nonbank financing4 less payment of domestic arrears on pensions, to international organizations, and court awards, relative to the programmed cumulative amounts presented in Schedule C. For the purpose of this adjuster, payment of such arrears cannot exceed the programmed amount by more than Ush 45.0 billion.

Schedule C: Nonbank Financing Minus Repayment of Domestic Arrears

(Cumulative billions of Uganda’s shillings, beginning July 1 of the fiscal year)

Quarter6/30/2011 1/9/30/2011 2/12/31/2011 2/3/31/2012 2/6/30/2012 2/
(A) Nonbank Financing392.0023.8554.472.0100.0
(B) Repayment of domestic arrears on pensions, to international organizations, and for court awards184.0021.4571.571.571.5
(C) Total = (A) - (B)208.002.40-17.140.4928.50
Source:

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

Source:

Cumulative from July 1, 2010; and

Cumulative from July 1, 2011

15. The ceiling on NDA of the BOU for every test date will be adjusted upward by the daily average amount of commercial bank automatic access to the BOU discount window and rediscounting of government securities by commercial banks.

16. The ceiling on NDA of the BOU for every test date will be adjusted downward/upward to reflect decreases/increases in the legal reserve requirements on deposits in commercial banks. The adjuster will be calculated as the percent change in the reserve requirement multiplied by the actual amount of required reserves (Uganda shillings and foreign-currency denominated) at the end of the previous calendar month.

IX. Ceiling on the Contracting or Guaranteeing of New Nonconcessional External Debt by the Public Sector, and Ceiling on the Stock of External Payments Arrears Incurred by the Public Sector5

17. The assessment criterion on short-term debt refers to contracting or guaranteeing external debt with original maturity of one year or less by the public sector. Excluded from this assessment criterion are normal import-related credits and non-resident holdings of government securities and government promissory notes. The definition of “debt” is set out in paragraph 18.

18. The program includes a ceiling on new nonconcessional borrowing with maturities greater than one year contracted or guaranteed by the public sector.6 Nonconcessional borrowing is defined as loans with a grant element of less than 35 percent, calculated using average commercial interest rates references (CIRRs) published by the Organization for Economic Cooperation and Development (OECD). In assessing the level of concessionality, the 10-year average CIRRs should be used to discount loans with maturities of at least 15 years, while the 6-month average CIRRs should be used for loans with shorter maturities. To both the 10-year and 6-month averages, the following margins for differing payment periods should be added: 0.75 percent for repayment periods of less than 15 years; 1 percent for 15-19 years; 1.15 percent for 20-25 years; and 1.25 percent for 30 years or more. The ceiling on nonconcessional external borrowing or guarantees is to be observed on a continuous basis. The coverage of borrowing includes financial leases and other instruments giving rise to external liabilities, not only current as defined below, but also contingent, on nonconcessional terms. External debt for the purpose of this assessment criterion means borrowing giving rise to liabilities to non-residents. Excluded from the limits are changes in indebtedness resulting from non-resident holdings of government securities and government promissory notes, refinancing credits and rescheduling operations, and credits extended by the IMF. For the purposes of the program, arrangements to pay over time obligations arising from judicial awards to external creditors that have not participated in the HIPC Initiative do not constitute nonconcessional external borrowing. Excluded from these limits are also nonconcessional borrowing within the limits specified in Table 1 of the MEFP. The ceiling also excludes nonconcessional borrowing by one state-owned bank, Housing Finance Bank, which poses limited fiscal risk and is in a position to borrow without a government guarantee.

19. The definition of debt, for the purposes of the limit, is set out in point 9 of the Guidelines on Performance Criteria with Respect to External Debt (Executive Board’s Decision No. 6230-(79/140), as amended by Decision No 14416-(09/91, effective December 1, 2009). It not only applies to the debt as defined in Point 9 of the Executive Board decision, but also to commitments contracted or guaranteed for which value has not been received. The definition of debt set forth in No. 9 of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangements reads as follows:

(a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lesser retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair, or maintenance of the property. (b) Under the definition of debt set out in point 9(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

20. The ceiling on the accumulation of new external payments arrears is zero. This limit, which is to be observed on a continuous basis, applies to the change in the stock of overdue payments on debt contracted or guaranteed by the public sector from their level at end-June 2006. External debt payment arrears consist of external debt service obligations (reported by the Statistics Department of the BOU, the Macro Department of the Ministry of Finance) that have not been paid at the time they are due as specified in the contractual agreements but shall exclude arrears on obligations subject to rescheduling.

X. Monitoring and Reporting Requirements

21. The authorities will inform the IMF staff in writing at least ten business days (excluding legal holidays in Uganda or in the United States) prior to making any changes in economic and financial policies that could affect the outcome of the financial program. Such policies include but are not limited to customs and tax laws (including tax rates, exemptions, allowances, and thresholds), wage policy, and financial support to public and private enterprises. The authorities will similarly inform the IMF staff of any nonconcessional external debt contracted or guaranteed by the government, the BOU, or any statutory bodies, and any accumulation of new external payments arrears on the debt contracted or guaranteed by these entities. The authorities will furnish an official communication to the IMF describing program performance of quantitative and structural assessment criteria and benchmarks within 8 weeks of a test date. The authorities will on a regular basis submit information to IMF staff with the frequency and submission time lag as indicated in Table 1. The information should be mailed electronically to AFRUGA@IMF.ORG.

Table 1.Summary of Reporting Requirements
Reporting institutionReport/TableFrequencySubmission lag
I. Bank of UgandaIssuance of government securities.Weekly5 working days
Interest rates on government securities.Weekly5 working days
Operations in the foreign exchange market and daily average exchange rates.Weekly5 working days
Consumer price index.Monthly2 weeks
Balance sheet of the BOU, consolidated accounts of the commercial banks, and monetary survey. The Internal Audit Department (IAD) of the BOU will, on quarterly basis, review the reconciliations of monetary survey data with the financial records and the audited financial statements. Any revisions to monetary survey data will be documented and reconciled with the previous presentation to ensure accurate reporting.Monthly4 weeks
Composition of foreign assets and liabilities of the BOU by currency of denomination.Monthly4 weeks
Statement of (i) cash balances held in project accounts at commercial banks; (ii) total value (measured at issue price) of outstanding government securities from the Central Depository System (CDS); and (iii) the stock of government securities (measured at issue price) held by commercial banks from the CDS.Monthly6 weeks
Summary of (i) monthly commodity and direction of trade statistics; (ii) disbursements, principal and interest, flows of debt rescheduling and debt cancellation, arrears, and committed undisbursed balances—by creditor category; and (iii) composition of nominal HIPC Initiative assistance, disaggregated into grants, flow rescheduling, and stock-of-debt reduction by creditor.Monthly6 weeks
Summary of stock of external debt, external arrears, and committed undisbursed loan balances by creditor.Quarterly6 weeks
Standard off-site bank supervision indicators for deposit money banks.Quarterly4 weeks
Summary table of preliminary program performance comparing actual outcome with adjusted program targets for (i) base money; (ii) net claims on central government by the banking system; (iii) stock of external arrears; (iv) new nonconcessional external borrowing; and (v) net international reservesQuarterly5 weeks
Daily average amount of commercial bank automatic access to the BOU discount window and rediscounting of government securities by commercial banks.Quarterly4 weeks
II. Ministry of FinanceSummary of central government accounts. Revenues shall be recorded on a cash basis. Expenditures shall be recorded when checks are issued, except for domestic and external debt-service payments, cash transfers to districts, and externally funded development expenditures. Expenditures on domestic interest will be recorded on an accrual basis and external debt service will be recorded on a commitment basis (i.e., when payment is due). Cash transfers to districts will be recorded as expenditures of the central government when the transfer is effected by the BOU. Expenditures on externally funded development programs will be recorded as the sum of estimated disbursements of project loans and grants by donors, less the change in the stock of government project accounts held at the BOU and domestic commercial banks.Monthly6 weeks
Summary of outstanding stock of verified domestic arrears comprising the stock of CCS/IFMS arrears incurred after end-June 2004.annually6 weeks
Summary of contingent liabilities of the central government. For the purpose of the program, contingent liabilities include all borrowings by statutory bodies, government guarantees, claims against the government in court cases that are pending, or court awards that the government has appealed.Quarterly6 weeks
Detailed central government account of disbursed budget support grants and loans, HIPC support, and external debt service due and paid.Monthly4 weeks
Detailed central government account of disbursed donor project support grants and loans.Monthly6 weeks
Statement on new loans contracted during the period according to loan agreements.Quarterly6 weeks
Updated national accounts statistics (real and nominal) according to UBOS and medium-term projections.Quarterly4 weeks

Exceptional security-related spending (FY09/10-10/11) and capital gains tax from oil (FY10/11) not included.

The budget speech reflects a somewhat different mix of external financing (more grants versus loans) based on updated information. This reduces the fiscal deficit since loans are a financing item, but leaves spending broadly consistent.

Another large project will be financed by new external nonconcessional borrowing, which had not yet been incorporated into the macroeconomic framework at the time of the first review.

Food accounts for 27 percent of the CPI basket; about half of this is also included in the measure for core inflation.

The framework also does not include oil production revenues, which should commence in 3-4 years, since the amount of production is still under debate. While such revenues will be earmarked for infrastructure projects, and thus will not count in international reserves, they will nevertheless represent foreign exchange resources that the government can use for specified imports.

By end-March 2011, all banks had complied with the new minimum capital regulations, which raised the floor on paid-up capital for existing banks to Ush 10 billion (US$4.2 million). The new regulations require all new banks to have a minim capital of Ush 25 billion (US$10.4 million) and allow existing banks until March 2013 to meet this higher requirement.

Use of the ceiling is based on contracting, while the macroeconomic framework reflects disbursements of the loans. US$460 million has been contracted so far, although the loans from Chinese lenders (US$100 million for road construction equipment and US$350 million for the new Kampala-Entebbe toll road) just barely miss the 35 percent grant element needed to qualify as concessional.

The central government comprises the treasury and line ministries.

The Auditor General’s report (http://www.oag.go.ug/annual_reports.php?dId=1) for FY 2009/10 indicates that some agencies could not disclose their outstanding operating commitments in their financial statements at year’s end.

Debt service due is defined as pre-HIPC Initiative debt service due, but from 2003/04 onwards, this excludes debt service subject to HIPC Initiative debt rescheduling.

Comprising the check float and the change in government securities and government promissory notes held by the nonbank sector. The change in government securities held by the nonbank sector will be calculated from the data provided by the Central Depository System (CDS).

Public sector comprises the general government (which includes the central government, local governments, and monetary authorities), and entities that are public corporations which are subject to ‘control by the government’, defined as the ability to determine general corporate policy or by at least 50 percent government ownership.

Contracting and guaranteeing is defined as approval by a resolution of Parliament as required in Section 20(3) and 25(3) of the Public Finance and Accountability Act, 2003

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